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Electronic Markets, Search Costs, and Firm Boundaries

Author

Listed:
  • Ramesh Sankaranarayanan

    (School of Business, University of Connecticut, Storrs, Connecticut 06269)

  • Arun Sundararajan

    (Leonard N. Stern School of Business, Kaufman Management Center, New York University, New York, New York 10012)

Abstract
We study how interorganizational systems (IOS) such as electronic markets and other enabling information technologies that facilitate broader interfirm transactions affect the extent of outsourcing in firms. We do so by modeling firms in a three-tier value chain consisting of buyers, intermediaries, and suppliers, who can interact using IOS that lower the procurement search costs associated with finding appropriate trading partners. In the context of complex business-to-business (B2B) search, we study how decreasing search costs affect a firm's decision to insource or outsource the procurement function, depending on whether the search process is information intensive or communication intensive. Variation in search costs changes the transaction costs of interaction between firms, as well as the contracting costs associated with outsourcing, owing to changes in the costs of moral hazard for delegated search. We study these effects in a new model that integrates search theory into the principal-agent framework, and establish that the optimal outsourcing contract has a simple “all or nothing” performance-based structure under fairly general assumptions. Our model predicts that when B2B search is information intensive, IOS will facilitate an increase in outsourcing, market-based transactions, and a reduction in the vertical scope of extended enterprises. In contrast, when B2B search is primarily communication intensive, IOS will lead to tighter integration and an increase in the vertical scope of the extended enterprise. Our research suggests that the nature of the information technologies and of the business activities supported by IOS are crucial determinants of the organizational and industry changes they induce, and our results have important implications for a variety of industries in which both technological and agency issues will influence the eventual success of global IT-facilitated extended enterprise initiatives.

Suggested Citation

  • Ramesh Sankaranarayanan & Arun Sundararajan, 2010. "Electronic Markets, Search Costs, and Firm Boundaries," Information Systems Research, INFORMS, vol. 21(1), pages 154-169, March.
    • Handle: RePEc:inm:orisre:v:21:y:2010:i:1:p:154-169
    DOI: 10.1287/isre.1090.0235
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    References listed on IDEAS

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    Cited by:

    1. Zand, Fardad & Van Beers, Cees & Van Leeuwen, George, 2011. "Information technology, organizational change and firm productivity: A panel study of complementarity effects and clustering patterns in Manufacturing and Services," MPRA Paper 46469, University Library of Munich, Germany.
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    4. Sulin Ba & Barrie R. Nault, 2017. "Emergent Themes in the Interface Between Economics of Information Systems and Management of Technology," Production and Operations Management, Production and Operations Management Society, vol. 26(4), pages 652-666, April.

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